Some employers that sponsor a 401(k) retirement plan offers employees the option to contribute to a Roth 401(k). In a Roth 401(k), wages are taxed when contributed to the account. When distributions from the account are eventually received, the withdrawals are usually tax-free. As with a Roth IRA, the earnings that accumulate in the account are part of the tax-free withdrawal.

The Roth 401(k) option is less common than the regular 401(k) because of the additional administrative duties imposed on plan sponsors. Despite its name, a Roth 401(k) has some important differences from the better-known Roth IRA. Before deciding which type of 401(k) to choose, a prospective participant should understand some distinctive features of a Roth 401(k).

No Roth treatment for employer contributions

With a regular 401(k), the employee contribution and any matching employer contribution are both tax-deferred. You might assume that the employer contribution to a Roth 401(k) would be taxed up front, along with the employee contribution. However, an employer contribution to a Roth 401(k) must remain tax-deferred. Therefore, a Roth 401(k) account can contain both pre-tax and post-tax funds.

Required minimum distributions

Roth IRAs are useful in retirement planning partly because there is no specific age at which distributions must begin. In contrast, the account owner must start to take withdrawals from a Roth 401(k) no later than age 70 1/2. For many individuals, however, the advantage of a Roth IRA can be realized by rolling over some or all of their Roth 401(k).

A Roth 401(k) may be rolled over to a Roth IRA after your employment has ended with the company that sponsored the plan. However, any pre-tax portion of your 401(k) contributed by your employer is not designated as a Roth 401(k). To avoid taxation on the rollover of the regular 401(k) portion, you could move the funds into a traditional IRA.

No benefit from 401(k) forfeitures

Some employees leave their place of employment relatively soon after joining the company's 401(k) plan. Because they are not yet vested, departing employees sometimes forfeit some or all of their 401(k) contributions. Those forfeited amounts cannot accrue to the benefit of the Roth 401(k) accounts in a 401(k) plan.

Your company may allow you to allocate your contributions between a regular 401(k) and a Roth 401(k). If so, your age is one of the several factors that help determine the most appropriate allocation. Contact a financial planning service for more information about Roth 401(k) accounts.